Peak Bond Demand——Now Comes The $8 Trillion EM Forex Unwind

BY MIKE DOLAN at Reuters

China’s summer shock may mark the end of an era of globalization that helped define world markets for more than a decade.

Investor anxiety about the consequences is well-founded.

Beijing’s integration into the global economy since 2002 reshaped the financial as well as economic landscape – mainly by the way China itself and the economies it supercharged with outsize demand for raw materials banked the hard cash windfalls they earned over the following 12 years.

According to the International Monetary Fund, the dollar value of foreign currency reserves held by all developing nations ballooned by almost $7 trillion in just one decade to a peak of some $8.05 trillion by the middle of last year.

While China was the main driver, accounting for about half of that increase, its economic boom created a commodity supercycle that flooded the coffers of resource-rich nations from across Asia to Russia, Brazil and the Gulf.

As the vast bulk of this hard cash was banked in U.S. Treasury and other low risk, rich-country bonds, they were at least one critical factor in the halving of U.S. Treasury and other Group of Seven government borrowing costs over the same period.

Alongside the disinflationary impact of China’s low cost labor on western goods imports and wages, this reserve stash helped extend what has now been a 20-year bull market in bonds.

What’s more, the drop in yields, by skewing relative returns between stocks and bonds and also the relative cost of capital for companies, also at least partly underwrote a post-credit crisis surge in equity prices to successive records.

Reverse that bond buying, even at the margin, and world asset markets may have a major problem.

That’s especially so at a time when the big other marginal bid for bonds, the U.S. Federal Reserve’s quantitative easing program, has ended and when

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